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The return of stagflation?

Stagflation isn’t a word that has been used much in recent years, but, in a number of countries, there are hints that we may need to dust off the term.

One of the most explicit comments came last week from India’s Finance Secretary, Mr Gujral, who told Reuters, ‘The Indian government is concerned about high inflation and slowing growth.’ That followed a 25 basis point rise in the repo rate, to 8.25%, the 12th increase in 18 months. However, with inflation at a 13 month high of 9.78%, that still leaves the official rate in negative real territory, so analysts are expecting further rate increases over the next few months.

Growth is expected to reach 8.5% for the fiscal year to March 2012 – a rate that Western nations can only dream of – but with real wages now falling, consumers are feeling the pain of higher prices, and fuel price increases in particular are helping to make the Indian government hugely unpopular.

Amongst the other BRICS, consumer price inflation is at 7.2% in Brazil, 8.2% in Russia, 6.2% in China and 5.3% in South Africa.

The Chinese rate reached a three year high in July, (compared with a target of 4%), in this case largely fuelled by rising food prices. China’s central bank has raised interest rates five times since October 2010 in an attempt to control inflation and it has increased the reserve ratio requirements for banks nine times during the period. The obvious response would normally be for the Renminbi to appreciate, but of course this is ruled out by the managed exchange rate that the Central Bank still operates.

Speaking at the World Economic Forum in Dalian last week, Premier Wen Jiabao re-iterated that China will keep monetary policy tight to contain inflation, while forging ahead with structural reforms and boosting consumption to sustain long-term economic growth. But even so, rising costs are starting to hurt that growth by making Chinese companies less competitive than in other Asian nations.  A recent report by KMPG says that minimum wage levels in China are now four times greater than other places in South and South East Asia, with Indonesia and Bangladesh benefiting most.

Once again the growth rate of 9.5% in the year to the second quarter is enviable by Western standards, but it was a slowdown from the 9.7% rate recorded in the first quarter.

The Asian Development Bank has warned more generally that rising consumer prices, either breaching or remaining near the upper end of central bank targets, are hurting growth in the emerging East Asian economies, with annual growth in the region’s ten largest economies moderating to 8.1%, in the first quarter of 2011, down from 8.4% in the previous three months.

Meanwhile, over the last week the International Monetary Fund has urged Russia to extend its monetary policy tightening to bring inflation down toward a medium-term rate of 3-5%, whilst forecasting that growth would hit 4.8% before slowing to 4.5% next year. But from the government’s position, Russia is already on track to reach a post-Soviet record low inflation rate this year, which may even come below the 6.5-7.0% official forecast. Raising interest rates at this stage would be at odds with the government’s objective of curtailing the rouble’s appreciation, with Deputy Economy Minister Andrei Klepach saying he believes the currency is already overvalued by at least 10%, pushing the country towards slower growth and a current account deficit in the medium term.

The situation looks very different in the United States and the United Kingdom, where inflation is rising, but the risk to the economies is of a second recession, hence although the Central Banks are concerned about above desired inflation rates, they are even more concerned about the lack of demand, and with rising government deficits already causing the markets concern, there is perceived to be little scope for further fiscal stimulus, putting all the pressure on monetary policy.

One of the difficulties is that although official interest rates are at historic lows, with risk aversion rising this does not necessarily translate into low rates for private borrowers, and negative real interest rates on government bonds combined with low growth tends to lead to currency depreciation –which of course further hurts inflation and real wages – escalating the stagflationary vicious circle.

In the UK inflation reached 4.5% last month, the highest it has been for almost 3 years, and many expect it to rise to around 5% by the year end.

The headline rate is lower in the US, where excluding food and energy it was just 2% year on year in August, but that was still the highest 12-month rate since late 2008, and led to a 1.8% annual drop in the real average weekly wages of U.S. workers.  

The one slight silver lining in this dark cloud for the US and the UK is that inflation does help to erode the real value of debt.

The eurozone doesn’t even have this glimmer of light. There inflation does look to be under tight control (at least as long as the euro itself remains intact), but is accompanied by forecasts from the European Commission that growth will come ‘to a virtual standstill’ in the second half of this year. So in this area it is simple stagnation, the ‘Japanese disease’, rather than stagflation that is the issue. But of course the demise of the euro could rapidly change that.